Insurers study climate change to decide rate hikes in Alabama

View full sizeAlabama Insurance Commission Jim L. Ridling says the state's April 27 tornado rampage is likely to drive up property insurance rates for state residents, but "I don't think you are going to see a huge rate increase by this one event."

MONTGOMERY, Alabama -- Homeowner's insurance rates are likely to go up in the wake of the deadly and costly April 27 tornado outbreak, but the extent of the increase will vary by company and will depend on whether the storms are considered a freakish anomaly or part of a new normal for tornado risk.

Alabama Insurance Commissioner Jim L. Ridling said his department, which oversees the insurance industry, has had discussions with major reinsurance companies in recent weeks and they have indicated that they are anticipating a 7 percent to 10 percent increase in their rates.

Insurance companies buy reinsurance to defray some of their own costs in case of disaster. An increase in cost for reinsurance will trickle down to consumers.

"The reinsurance market will drive a lot of this cost," Ridling said. "But I don't think you are going to see a huge rate increase by this one event."

The insurance commissioner said that, based on modeling firms' predictions, total insured losses in Alabama from the April 27 storms will be in the range of $2.5 to $3.5 billion.

Long before the storms hit, home insurance rates were already on the rise.

Within the past year, Illinois-based State Farm, which has 29 percent of the state homeowners market, increased home insurance premiums by an average of 8.2 percent. Montgomery's Alfa Mutual Insurance Co., the No.$?2 insurer with a 16 percent share of the market, increased rates by 18 percent. Allstate Corp., based in Illinois, with a 6.5 percent market share, upped its homeowner rates in Alabama by an average of 9.9 percent.

According to insurance industry experts, home insurance rates aren't set to recoup losses from a disaster. Instead, they are set to cover predicted future losses.

Insurers have to justify any proposed rate increase to Alabama's Department of Insurance by providing information on the history of claims paid out, the amount of money the companies have set aside to pay claims and their projections of what they may have to pay out in the future.

Lee Bowron of the Birmingham actuarial consulting firm Kerper and Bowron LLC said insurance companies use models that project the likelihood a homeowner might experience a particular event and how much such an event would cost an insurer.

"These models make assumptions about the frequency of hurricanes, tornadoes, and other perils," Bowron said. "They also estimate how much damage a storm would impact an insurance company based on how many homes they have and where they are located. Typically, a model will simulate a long time horizon and estimate the average storm losses per year as well as the impact of the most severe storms."

The impact of tornadoes in April and May of this year is being plugged into those models, Bowron said.

"Reinsurers and insurers are now evaluating tornado risk in light of the recent outbreak," Bowron said. "They will be checking their models to see if prior assumptions about both the frequency of tornadoes and the severity of the losses generated by the tornadoes need to be changed."

Sometimes an event happens that changes their equations.

"I think, in general, when you see a big catastrophic loss like this, companies are going to be seeking rate increases," Bowron said.

While no one wants to pay more for home insurance, it is also important that insurers are making enough in premiums to cover their losses.

"Being able to get rate increases helps the companies stay viable," Bowron said.

It is doubtful any of their models predicted the size and scope of April's disaster.

Just halfway through the year, Alabama's preliminary total of 108 tornadoes in 2011 has already exceeded the all-time record year for tornadoes, eclipsing the record of 94 in 2008.

In fact, the number of monthly tornadoes in April alone exceeded the previous annual record number of tornadoes in Alabama. The 2011 total so far is almost three times as many tornadoes as Alabama's 30-year average of 37 tornadoes annually.

Also, 2011 already has set the record for the most powerful tornadoes. This year now holds the record for most F4/EF4 and F5/EF5 tornadoes in a single year.

Future

But is there any reason to believe that this unparalleled event indicates something about the future?

Worldwide, re-insurers are paying close attention to global climate change and predictions of its effects are being factored into models. In a recent report, giant Swiss Re wrote: "There looms the threat that climate change will only exacerbate the frequency and severity of weather-related events."

Hurricanes, for instance, are expected to become more powerful in a warming world.

But what effect, if any, climate change may have on the frequency and power of tornadoes is unknown.

A preliminary National Weather Service evaluation of climate variables known to cause tornadoes in the Southeast doesn't show a global warming-related trend that can be linked to the severe outbreak.

According to Kevin Pence, the science and operations officer at the NWS office in Birmingham, a team from the National Oceanic and Atmospheric Administration looked back over decades of data for the Southeast and found no discernible trend in the key ingredients of tornado formation: available water vapor, atmospheric instability and wind sheer.

Pence said the average number of documented tornadoes in Alabama has been on the increase over time, but NWS scientists believe that increase is due to better detection and documentation of weaker tornadoes.

The number of strong tornadoes varies from year to year but has been relatively constant over time.

However, there is a growing awareness in the meteorological community that the Southeast's Dixie Alley is slightly more prone to powerful, long-traveling tornadoes than the traditional Tornado Alley of the Great Plains.

And weather scientists do see a possible relationship between the weather phenomenon known as La Nina and the tornado outbreak, and some in the weather world are exploring whether climate change is causing a disruption in the El Nino/La Nina cycle.

Brian Thomas, a sustainability consultant who formerly worked in the reinsurance industry, said that teams of scientists employed by the industry are looking at these questions.

"The insurers are asking themselves the same question: What if this is a new pattern? What if this is going to mean there will be more tornadoes?" he said. "The global re-insurers are very concerned about climate change. As far as they are concerned, there is a pretty clear signal."

Whatever calculations individual companies make about future risk, there will also be a countering force keeping rates in check, said William Rabel, a professor at the University of Alabama Culverhouse College of Commerce.

The companies may want to raise rates but they are also keeping an eye on what competitors are doing, he said; raise them too much and a company loses customers.

"Insurance companies want to recoup their losses but they also want to remain competitive," he said.

No one expects the tornadoes to drastically limit the number of insurers willing to write policies in central and north Alabama the way repeated hurricanes on the Gulf Coast have significantly limited choices and driven up costs for insurance in the coastal zone.

Homeowners insurance hasn't been particularly profitable in recent years, but there are many players in the market. Some insurance companies have indicated that they'll make other changes to boost profits, such as making the renewal of a homeowner's policy contingent on the homeowner also using the same company to insure the household's automobiles, which has been a more profitable line of business.

Spokesmen for the three biggest insurers all said that a single event doesn't lead to a hike in rates but that companies are constantly evaluating future risk based on their claims experience.

"There is just no question that there has been an increased severity and frequency of storms and that increased storm activity is putting pressure on rates," said Jeff Helms, a spokesman for Alfa. "When you have that increased severity and frequency over several years, that changes your rates for the future."

Alfa is anticipating 21,700 claims from home and auto owners from the April storms. Helms said a vast majority of those claims have already been paid. State Farm spokesman David Major said the company received 14,500 homeowner claims and 6,500 auto claims from the storms. The company insures about 300,000 Alabama households.

"We are financially sound and able to pay for the losses from the April 27 storm," Major said.

Reevaluating rates is part of the normal course of business. "We try and do that in anticipation of what our future needs will be rather than looking backward and making up money that we have paid out," Major said.

John Heid, spokesman for Allstate's Southeast region, said Allstate has no current plans for raising rates or changing policy writing practices in the state but, like all companies, reevaluation is a constant.

"One event doesn't typically change rates. There are a lot of factors involved," he said. "We are poised to protect our customers and to make sure we were able to do that."